Flipping in the Pandora Business Model

A few posts ago, we discussed the Pandora business model. Pandora.com has been a huge success capturing musical market share and has a terrific business model in many ways. However, there are some difficulties with the model, particularly, the direct relationship between use o f the site and cost. This low margin issue is today’s topic.

What can Pandora do to create innovation in the area of margin? The most common responses are:

Charge more users

Charge more for services

Offer more premium services or charge more for them

Limit the time a user can spend on the site

Tie usage of the site to ad clicks. That is, the more a user clicked on advertisements, the more free time they would get.

Negotiate a better deal with the record companies and/or artists.

While some of these options could improve Pandora’s margins, I do not believe any of these are radical enough to double Pandora’s stock price. What could Pandora do to dramatically change its margin formula and thereby dramatically improve its business model?

Pandora lets users choose their favorite genre or artist and then pays significant royalties on these works. At the same time, thousands of talented musicians are paying to have their videos featured on YouTube and other sites. American Idol gets millions of Americans to pay (with their time) to watch unknown artists each week. There seems to be an opportunity for Pandora to do a YouTube/American Idol/Pandora Mashup.

If a user creates a Maroon 5 channel, Pandora throws in similar artists they think the user will like. These songs are almost always from known artists who demand play royalties. If the user has the Billy Joel channel playing, she will hear Elton John and Steely Dan too. What’s the point? The point is that Pandora already plays “I think you will like this” selections without asking the user. What if one out of every ten songs on the user’s channel was a similar but unknown artist? This would cut Pandora’s royalty payments by ten percent plus allow Pandora to collect placement fees from the up and coming artist’s label. Working under the assumption that Pandora could collect double the play royalty from the up and comers, this would cut the overall royalty structure by 30%. Now that’s a big business model innovation!

In addition, Pandora has an opportunity to compete with American Idol by creating a series of user’s choice channels for paid and unpaid placements. Pandora could have video interviews with the contestants, performance of their own music, and American Idol style Karaoke songs. This would allow Pandora to effectively become a music label. Multiple revenue streams could flow from this including: all the traditional music label revenue, concerts, artist management fees, and royalty-free play on Pandora.

What are the potential downsides to this plan? The most significant is whether users would tolerate one song in ten from an unknown artist. I believe Pandora could pull this off. One in ten is not intrusive, the user can fast forward, and Pandora has far fewer commercials than traditional free radio. With the ability to cut royalties by 30%, this option merits a try.

American Idol-Pandora style is only risky in that it may not gain traction. A certain critical mass is needed to have a weekly vote. For Pandora Idol to work, significant buzz would need to be built in an already crowded category. The one advantage Pandora would have is a much lower cost business model, as they do not need to produce a TV show. This one is worth a shot.

The alternative record label is the trickiest. This tactic would certainly alienate the existing record labels. The real issue is “can the labels do anything about it?” If Pandora pays a royalty like any other radio station based on listeners, does it matter that the record labels hate them? If the record labels would be angry but helpless, this is a good option. If the record labels could exert force or pressure on Pandora, this option is probably best foregone.

The Business Model Institute uses a proprietary eight-part business model assessment methodology to help small-to-mid-sized businesses assess and improve their business models. If you need advice on creating a new business model, want to learn business model secrets and/or trends or want to know how to create a more effective business model then the Business Model Institute can help.